January 27, 2013

Jeff Frankel: Monetary Alchemy, Fiscal Science

Jeff Frankel:

Monetary Alchemy, Fiscal Science: The austerity-versus-stimulus debate has been thoroughly hashed out…. [T]he long-term consequences of permanently expansionary macroeconomic policy… are unsustainable deficits, debts, and inflation…. [I]n the aftermath of a recession, when unemployment is high and inflation low, the immediate consequences of contractionary macroeconomic policy are continued unemployment, slow growth, and debt/GDP ratios that go up rather than down….

Less thoroughly aired recently is… whether… monetary or fiscal expansion is the more effective instrument…. The answer to the question which form of policy is more effective: under the circumstances that held in the 1930s and that hold again now - which are conditions not just of high unemployment and low inflation, but also near-zero interest rates — stimulus in the specific form of fiscal expansion is much more likely to be effective in the short-term than stimulus in the form of monetary expansion…. The hoary — but still evocative — metaphor is “pushing on a string.” Meanwhile, fiscal expansion is rendered relatively more effective, in that it doesn’t push up those rock-bottom interest rates and thereby crowd out private-sector demand…. It is worth trying all sorts of things: quantitative easing, forward guidance, nominal targets. But the effects of each are highly uncertain.

That monetary policy is less effective than fiscal policy under conditions of high unemployment and zero interest rates should not be a novel position. But many economists have forgotten much of what they knew and politicians may not have even heard the proposition…. A new wave of econometric research estimates fiscal multipliers using methods that allow them to be higher in some circumstances than others. Baum, Poplawski-Riberio and Weber (2012)… Batini, Callegari and Melina (2012)… Auerbach and Gorodnichenko (2012a, 2012b), Baum and Koester (2011), and Fazzari, Morley and Panovska (2012). Most of this research finds high multipliers under conditions of excess capacity and low interest rates. (Few of them have the courage to mention that this is what one would have expected from the elementary textbooks of 50 years ago, perhaps due to fear of sounding old-fashioned.)…

Needless to say, the effects of fiscal policy are subject to substantial uncertainty… the United States would be well-advised to lock in a long-term path toward debt sustainability, even while undertaking a little short-term stimulus…. Nevertheless, if the question is whether it is monetary policy or fiscal policy that can more reliably deliver demand expansion under current conditions, the answer is the latter. One might even dramatize the contrast by speaking of “monetary alchemy and fiscal science.”

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Jeff Frankel: Monetary Alchemy, Fiscal Science

Jeff Frankel:

Monetary Alchemy, Fiscal Science: The austerity-versus-stimulus debate has been thoroughly hashed out…. [T]he long-term consequences of permanently expansionary macroeconomic policy… are unsustainable deficits, debts, and inflation…. [I]n the aftermath of a recession, when unemployment is high and inflation low, the immediate consequences of contractionary macroeconomic policy are continued unemployment, slow growth, and debt/GDP ratios that go up rather than down….

Less thoroughly aired recently is… whether… monetary or fiscal expansion is the more effective instrument…. The answer to the question which form of policy is more effective: under the circumstances that held in the 1930s and that hold again now - which are conditions not just of high unemployment and low inflation, but also near-zero interest rates — stimulus in the specific form of fiscal expansion is much more likely to be effective in the short-term than stimulus in the form of monetary expansion…. The hoary — but still evocative — metaphor is “pushing on a string.” Meanwhile, fiscal expansion is rendered relatively more effective, in that it doesn’t push up those rock-bottom interest rates and thereby crowd out private-sector demand…. It is worth trying all sorts of things: quantitative easing, forward guidance, nominal targets. But the effects of each are highly uncertain.

That monetary policy is less effective than fiscal policy under conditions of high unemployment and zero interest rates should not be a novel position. But many economists have forgotten much of what they knew and politicians may not have even heard the proposition…. A new wave of econometric research estimates fiscal multipliers using methods that allow them to be higher in some circumstances than others. Baum, Poplawski-Riberio and Weber (2012)… Batini, Callegari and Melina (2012)… Auerbach and Gorodnichenko (2012a, 2012b), Baum and Koester (2011), and Fazzari, Morley and Panovska (2012). Most of this research finds high multipliers under conditions of excess capacity and low interest rates. (Few of them have the courage to mention that this is what one would have expected from the elementary textbooks of 50 years ago, perhaps due to fear of sounding old-fashioned.)…

Needless to say, the effects of fiscal policy are subject to substantial uncertainty… the United States would be well-advised to lock in a long-term path toward debt sustainability, even while undertaking a little short-term stimulus…. Nevertheless, if the question is whether it is monetary policy or fiscal policy that can more reliably deliver demand expansion under current conditions, the answer is the latter. One might even dramatize the contrast by speaking of “monetary alchemy and fiscal science.”